In the largest tax overhaul since 1986, the Tax Cuts and Jobs Act passed by Congress seem set to affect all walks of America; those seeking divorce are certainly no exception. In myriad ways, these provisions will likely make divorce even more painful and complicated. Specifically, the new law’s changes on the tax treatment of alimony will create another hurdle for divorcing spouses and their lawyers to deal with when negotiating their division of property.
Understanding the Current Law
Under current law, ex-spouses who pay alimony can deduct that expense from their federal income taxes; ex-spouses receiving alimony payments have to claim the money received as taxable income. The spouse paying alimony usually earns more, and is therefore in a higher tax bracket than the spouse receiving payment. For example, if the paying spouse is in the 33% income tax bracket and the receiving spouse is in the 25% tax bracket, the parties, when looking at their income taxes as a whole, will pay 8% less in net taxes on the amount of alimony paid.
The practical effect of this, of course, is that the two ex-spouses will have more money between them as less money is being paid in taxes. Because of this, alimony has served as an incentive to the payor and a useful tool for reaching an agreement out of court. Contractual alimony has been used by divorcing spouses and their lawyers to come up with creative, interest-based divorce settlements that can leave both spouses with more money in their pockets at the end of the day.
The Big Tax Change Starting January 1, 2019
So what does the new law do? Beginning on January 1, 2019, in any divorce decree or property settlement that contains contractual alimony provisions, the paying party will not be able to deduct those payments from his/her taxes and the receiving party will not have to include those payments as taxable income.
Because divorcing spouses will no longer be able to use alimony as a tool for net tax savings, the new law takes away an incentive for parties to work together to reach a reasonable agreement out of court. Since the tax savings is no longer available and the availability of court-ordered, post-divorce spousal support (called “Spousal Maintenance” in Texas) is very limited in Texas, many suspect that contractual alimony will be less-frequently utilized and, if utilized, will be in proportionally smaller amounts than under the old tax law. From a practical perspective, this change in the tax treatment of alimony can make achieving a fair and equitable property settlement in a divorce more challenging.
Alimony has been historically used as a creative solution for many difficult settlement issues such as providing the lower income earning spouse (or perhaps a spouse who has stayed at home and not worked for many years during the marriage) a cash flow for a period of time after divorce in order to obtain the skills or education needed in order to gain employment, and other issues such as using alimony as a vehicle to compensate one spouse for that spouse’s community property interest in a difficult-to-divide asset being awarded to the other spouse (i.e. a closely held business, partnership, or other illiquid asset). This could result in settlement requiring a more complicated and messier division of assets (for example, ex-spouses co-owning a closely held business together after divorce or having to “fire sale” assets in order to liquidate and divide them in a divorce).
These changes regarding alimony will not affect anyone who finalizes their divorce before 2019; however, the writing on the proverbial wall has caused, according to one matrimonial lawyer, “calls from clients in a panic.”
Instead of relieving some of the sting in divorce, these new provisions stand to pile on more weight. This hits at a time when a soon-to-be former husband or wife are most vulnerable, economically and otherwise. At best, the changes will complicate divorce negotiations. At worst, they will place unfair, undue burden on alimony’s recipient, which are, a majority of the time, women. The bill summary acknowledges that the alimony change would lead to the federal government collecting an additional $8.3 billion in taxes from divorced couples over the next 10 years.
One of the most devastating realities for divorced couples turns out to be financial: two homes cost more than one, in more ways than one. The equation is not linear. Lifestyle adjustments are required at the same time a reduction of income hits each party. The effect these consequences have on children—will homes be sold, school districts change, private schools be too expensive?—cannot necessarily be anticipated to curtail the damage. The present tax structure has provided one way to lessen the weight of new living arrangements for divorcing spouses. The fear for some is that now the opposite will be true.
About the Author
Jonathan James is an associate attorney at Hance Law Group who exclusively handles family law matters, and has worked on cases ranging from paternity & custody disputes to complex property divorces. Mr. James is very comfortable in the courtroom and makes a personal investment in his clients’ cases in order to achieve the best outcome possible.